Fed holds rates steady despite volatile markets

updated 6:12 p.m. ET Aug. 7, 2007

WASHINGTON - Borrowers looking for some interest rate relief will have to keep on waiting.

Although Federal Reserve policymakers held interest rates steady Tuesday, they gave themselves some wiggle room for a cut down the road should economic conditions take a turn for the worse.

“Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses and the housing correction is ongoing,” said the Fed, its first acknowledgment of the recent conditions that have shaken Wall Street and Main Street. “Downside risks to growth have increased somewhat.”

The Fed did throw “investors a bone,” one analyst said, even though it stopped well short of saying a rate cut was imminent.

Fed Chairman Ben Bernanke and his central bank colleagues expressed hope that the economy will safely make its way. The policymakers also clung to their belief that the biggest potential danger to the economy is that inflation won’t recede as they anticipate.

Against these economic crosscurrents, the Fed left an important interest rate at 5.25 percent on Tuesday. In turn, commercial banks’ prime interest rate for certain credit cards, home equity lines of credit and other loans — would stay at 8.25 percent.

The central bank’s key rate hasn’t budged for more than a year. Before that, the Fed had raised rates for two years to fend off inflation.

On Wall Street, investors bid stocks higher. The Dow Jones industrials gained 35.52 points to close at 13,504.30.

Analysts believe the Fed probably will leave rates alone at its next meeting on Sept. 18. However, economists and investors now think the odds are growing that the Fed might lower rates by the end of this year — if the economy shows signs of faltering and if inflation isn’t worrisome.

For now, the Fed stuck to a forecast that the economy is likely to expand at a moderate pace in coming quarters. They also said they expected “solid growth in employment and incomes” — vital ingredients to the country’s economic health.

The Fed “didn’t completely satisfy investors but they did throw investors a bone,” said Mark Zandi, chief economist at Moody’s Economy.com. “They indicated that if things continue to weaken in financial markets, they will respond.”

The Fed was faced with a delicate dance, analysts said. To maintain credibility, it needed to acknowledge recent market gyrations, fears about a worsening housing slump and worries about a spreading and painful credit crunch. At the same time, it needed to send a comforting message but not be viewed as overly optimistic or pessimistic.

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